General aspects and processes for the management and methods for measurement of liquidity risk
Liquidity risk relates to the capacity or incapacity of the Group to meet its payment obligations and/or to raise additional funding (funding liquidity risk), or to the possibility that the amount obtained from the liquidation of some of its assets might be significantly different from the present market values (asset liquidity risk).
It is Group policy to maintain a low level of exposure to liquidity risk by employing a risk limit and management system based on gap analysis of cash flow (inflow and outflow) by residual maturity.
The primary objective is to meet the Group's payment obligations and/or to raise additional funding at a minimum cost and without prejudice to future potential income.
The following are responsible for liquidity risk management:
the Finance Area (1st level management) which monitors liquidity daily and manages risk on the basis of defined limits;
the Risk Management Area (2nd level management), responsible for periodically verifying that limits are observed.
The main objective of the analysis is to measure the degree of cover for the liquidity requirement of the Group and individual companies.
Liquidity risk is monitored using a liquidity gap model which calculates the net cash flows of the Group or of individual companies over time in order to detect any critical points in the expected liquidity. The total liquidity requirement is calculated as the sum of the negative gaps (outflows greater than inflows) recorded for each individual time period. Any positive gaps found in a time period are used to reduce negative gaps in subsequent periods.
The liquidity requirement thus calculated is compared to the total available liquidity (consisting of assets that can be liquidated immediately and assets that can be easily liquidated) in order to determine the cover for the risk generated by a position.
The consolidated liquidity requirement as at 31st December 2007 was entirely covered by liquidable assets, as was the case in the two previous financial years.
As part of the project for the second and third pillars of the Basel 2 programme, the UBI Banca Group has started the definition of a stress testing programme to measure the effects on liquidity management of specific events (sensitivity analysis) or of the combined changes in a set of economic and financial variables, hypothesising adverse scenarios (scenario analysis).
The scenarios are divided into three types:
ordinary operation, where liquidity concerns experienced by the Bank are not acute and are controlled by countermeasures which fall within the scope of ordinary operations with no impact on budgets;
Group specific crises, which involve resort to extraordinary countermeasures with intervention external to the Bank;
entire market crises.
Each specific crisis and market scenario is assessed according to three different levels of gravity. Seven dimensions were identified in the creation of the scenarios, changes in which have impacts of differing intensity on the determination of expected cash flows.
The Group has also set a specific initiative in motion to draw up an emergency contingency funding plan to deal with liquidity crises, with the following characteristics:
The primary purpose of the contingency funding plan (CFP) is to protect the assets of the Bank in situations of liquidity drainage by putting in place crisis management strategies and procedures to find sources of funding in cases of emergency. Consistent with the liquidity risk and structural balance guidelines in place at consolidated level, a policy was formulated which defines rules designed to pursue and maintain structural balance in the sources and uses of finance by the network banks and the product companies, by means of co-ordinated and efficient policies of funding and lending.
The objective of the policy, which replaces previous rules and operational procedures, is to standardise both the operating procedures and the criteria for identifying rates and charges across all Group member companies, identifying a priori any specific exceptions there may be.